It was David Freud, former journalist, investment banker, welfare adviser to Labour and now Tory minister, who wrote the 2007 report that made last week's furore over jobseekers working at the diamond jubilee possible.

Five years ago, the great-grandson of Sigmund Freud told the Labour government: "While there is no conclusive evidence that the private sector outperforms the public sector on current [employment] programmes, there are clear potential gains," adding: "Programmes should be outsourced into the private and voluntary sector, giving them the incentive to improve performance."

The message was clear: the public sector, namely the jobcentre, could not do the job alone – it was time for the profit-seekers to show of what they were made. The state moved aside and big business, often set up directly with government welfare money in mind, moved in.

The goal, according to Freud's report, was to tackle those furthest from getting jobs: the Neets, those 'not in education, employment or training'. Three hundred thousand lone parents, a million older people and a further million on incapacity benefit, were to be targeted.

He concluded that the welfare state as it stood was making some progress but that new ways to help people find work were necessary.

Each region would have a 'prime contractor' responsible for getting results but able to subcontract to others to get some of the training done.

The gain to the exchequer from moving someone back into work for a year would be £5,900 with wider gains from the tax that would be paid to the state raising that figure to £9,000.

In fact, Freud deduced that getting a benefit claimant into work for just one year would yield a great deal more by breaking a cycle of dependency on the taxpayer: as much as £62,000 per person to the state. Labour baulked at the radical solution but in 2010 the Tories came in determined to make it happen. It is not only private-sector firms that have moved in to take the place of the state and train the jobless. But the system does appear to be built with them in mind. Organisations receive fees for getting the jobless into work through a payment-for-results structure.

In normal economic times this is a system that could work well. But without any cash assistance upfront, a lack of jobs to put people into and minus the other money streams that private firms enjoy to keep them afloat, the reality in 2012 is different.

There is some irony, for example, in the collapse of Groundwork South West, an innovative charity that hoped to get enough people into work to earn £7m from the Department for Work and Pensions's Work Programme and make good the huge central and local government cuts to its funding. That aspiration led to the charity going bust under the weight of its overheads and making its 130 staff redundant. Some staff have been rehired by Prospects, a for-profit employment firm that has taken over the charity's work, but about two-thirds were left jobless.

A further 96 charity providers have dropped out of the Work Programme, many citing financial pressures, and Sir Stuart Etherington, chief executive of the National Council for Voluntary Organisations, said recently the government's flagship employment strategy was starting to resemble "a slow-motion car crash".

Gareth Thomas, the shadow charities minister, notes: "This is a tragic story entirely of ministers' making. Charities were led to believe that the Work Programme would be a source of new income even as the cuts in government funding bit hard."

Instead, the private firms are monopolising the welfare system and taking control over the fate of the half a million people referred to the programme.

There is no evidence that they are doing a better job than the state would have done – the statistics suggest a disappointing first year with less than 22% of benefit claimants finding any work – but then, as Lord Freud suggested in his consensus-forming report in 2007, that appears not to matter.

Chris Grayling, the employment minister, said: "It is absolute nonsense to say the Work Programme is in crisis. Quite the opposite. The Work Programme is about giving people the individualised help they need to find and stay in employment, and it is doing well. With the help of more than 400 voluntary organisations, along with hundreds of private and public providers, we are well on the way to 100,000 job starts."

Contract kings: the big five firms

Private firms contracted around the country by the government to deliver the Work Programme are responsible for organising the training and work placements necessary for the unemployed to "undertake active and effective jobseeking".

INGEUS UK LTD: Seven contracts worth £727m

Therese Rein, the wife of former Australian prime minister Kevin Rudd, is the company's managing director. The company paid £3.8m in dividends last year – and Rein holds around 97% of the firm's shares.

A4e LTD:Five contracts worth £438m

Earlier this year, four former members of staff of A4e were arrested on suspicion of fraud at the company dating back to 2010. Emma Harrison, who was paid a dividend of £8.6m in 2010, resigned as the prime minister's family tsar and as chair of the company over claims there was evidence of "systemic fraud" within the firm.

WORKING LINKS: Three contracts worth £308m

Working Links was formed three years ago by a merger of the government employment service, recruitment firm Manpower and Ernst & Young. Chairman Keith Faulkner admits: "If you have entered into a contract with government, you can decide whether your job is to maximise profit or to maximise your success in helping people find work and stay there."

AVANTA ENTERPRISE:Three contracts worth £267m

Avanta has arranged for jobseekers to work as unpaid cleaners in houses, flats, offices and council premises under the work programme. Its website says: "We're Optimistic. Creative. Stubborn. Challenging. Restless."

SEETEC:Three contracts worth £221m

The company's turnover last year was £53m and it employs more than 500 people. Its largest shareholder and chief executive, Peter Cooper, was paid nearly £2m in salary and share dividends in 2010.

• This article was amended on 16 June 2012 following a complaint from Avanta.